There’s an adage that says, “sentiment follows price," but recent action has broken that trend, with investor sentiment falling as we sit all-time highs. Given the rising bearishness, how should we proceed?
When it comes to market bullishness or bearish, there’s an adage that says, “sentiment follows price.” However, recent market action has broken that trend, with investor sentiment falling even as we sit all-time highs.
The American Association of Individual Investors (AAII) surveys its members weekly on the direction they believe the stock market is headed over the next six month, with responses ranging between up (bullish), no change (neutral), or down (bearish). One gauge of investor confidence is the Bull-Bear Spread (AAIISPREAD), calculated by subtracting the percentage of bearish respondents from the percentage that are bullish. A positive reading indicates more bulls than bears, while a negative reading suggests the opposite.
This week's survey showed only 28% of respondents had a bullish outlook compared to 49.5% with a bearish outlook, resulting in a spread of -21.5%. That level sits in the bottom 10% of historical surveys, placing us in abnormal territory. With bearish sentiment returning, should we brace for worse things ahead?
Interestingly, historical data suggests otherwise. Periods of low sentiment have often been followed by favorable market performances, while high sentiment tends to precede more muted returns, particularly at the extremes. Previous instances around current levels averaged solid returns over the following year, with one- and three-month returns ranking the highest of any group. That said, today’s reading is notable not only for its low level but also for occurring so close to all-time highs. As such, should we temper our expectations given the market’s elevated positioning.
Fortunately, history again points towards a constructive environment for equities. Nearly 90% of similar instances were positive after a month while the average return over the next several months significantly exceeded baseline expectations. While history doesn’t repeat, it often rhymes, and fading the market’s pessimism has historically worked out more often than not. Sentiment alone can’t fully predict market direction, but the generally positive takeaways from low-confidence periods are another sign of underlying strength, especially in the context of domestic equities’ long-term relative leadership.
